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PUBLICATIONS  OF  THE  GRADUATE   SCHOOL  OF 
BUSINESS  ADMINISTRATION,  HARVARD  UNIVERSITY 


VOL.  I,  NO.  4  CAMBRIDGE.  MASS.  JUNE,  1915 


BULLETIN  NO.  4 
BUREAU  OF  BUSINESS  RESEARCH 

DEPRECIATION  IN  THE 
RETAIL  SHOE  BUSINESS 


AT  .<.QZ  ARCSLSg 


L.  {  C  R:  A  "^  -^ 


ERieaJiOiGENTs 


BULLETINS  OF  THE  BUREAU   OF  BUSINESS  RESEARCH 

Bulletin  No.  1.   Object  and  History  of  the  Bureau  With  Some  Pre- 
liminary Figures  on  the  Retailing  of  Shoes 

Bulletin  No.  2.  Harvard  System  of  Accounts  for  Shoe  Retailers,  Expla- 
nation of  the  Profit  and  Loss  Statement 

Price  50  cents 
This  bulletin  is  accompanied  by  the  following  forms:  — 
Profit  and  Loss  Statement 
Monthly  Analysis  Sheet 
Six-month  Analysis  Sheet 

Bulletin  No.  3.  Harvard  System  of  Accounts  for  Retail  Grocers,  Expla- 
nation of  the  Profit  and  Loss  Statement 

Price  60  cents 
This  bxilletin  is  accompanied  by  the  following  forms: — 
Profit  and  Loss  Statement 
Monthly  Analysis  Sheet 
Yearly  Analysis  Sheet 

Bxilletin  No.  4.  Depreciation  in  the  Retail  Shoe  Business 

Price  60  cents 

(In  Preparation) 

Bulletin  No.  5.  Harvard  System  of  Stock-keeping  for  Shoe  Retailers, 
with  forms Price  60  cents 


The  Bureau's  bulletins  are  given  without  charge  to  those  who  cooperate 

with  the  Bureau  by  supplying  specific  information 

from  their  own  businesses. 


BULLETIN  NO.  4 
BUREAU  OF  BUSINESS  RESEARCH 


DEPRECIATION  IN  THE 
RETAIL  SHOE  BUSINESS 


CAMBRIDGE 

HARVARD  UNIVERSITY  PRESS 

1915 


CONTENTS 
Introduction 

PAOE 

Three  main  methods  of  depreciation  in  the  retail  shoe  trade  ...  3 

Object  of  this  bulletin 4 

Paut  1.     The  Treatment  of  Depreciation  on  the  Profit 

AND  Loss  Statement  of  the  Harvard  System 

OF  Accounts  for  Shoe  Retailers 

Depreciation  inevitable  but  usually  unmeasured 6 

Profit  and  Loss  Statement  for  first  period  of  a  shoe  store    ....  7 

Profit  and  Loss  Statement  for  second  period 8 

The  pith  of  mercantile  depreciation      9 

Table  illustrating  percentage  depreciation,  initial  and  cumulative  10 

Misconception  of  shoe  retailers  about  the  percentage  method  11 

Profit  and  Loss  Statement  for  third  period 12 

Comparative  table  of  the  three  statements  on  three  bases      ...  14 
Combined   basis  used  in  Harvard  System  of  Accounts  for  Shoe 

Retailers 16 

Summary  of  Part  I      17 

Part  II.    Instructions  for  Bookkeepers 

Ledger  accounts  needed  in  using  the  Harvard  System  of  Accounts 

for  Shoe  Retailers 20 

Profit  and  Loss  Account  and  Profit  and  Loss  Statement 21 

The  ledger  accounts  before  and  after  closing  at  end  of  first  period  22 

Making  up  the  Profit  and  Loss  Statement  from  the  ledger  accounts  25 
The  ledger  accounts  before  and  after  closing  at  end  of  second 

period 26 

The  ledger  accounts  at  end  of  third  period 30 

Memorandum  of  cost  of  depreciation 32 


DEPRECIATION  IN  THE  RETAIL  SHOE 

BUSINESS 

INTRODUCTION 

Bulletin  Number  2  made  the  following  statement  about  depreciation 
in  the  retail  shoe  trade:  — 

Depreciation  op  MERCHA^fDISE  is  not  insisted  upon  by  the  Bureau 
of  Business  Research,  nor  indeed  is  any  depreciation  account  essen- 
tial to  the  adoption  of  the  Harvard  System  of  Accounts  for  Shoe 
Retailers.  The  Bureau  does  recommend  earnestly,  however,  that  some 
depreciation  be  allowed  regularly,  and  wishes  to  know  from  its  coopera- 
tors  just  what  method  of  depreciation  is  followed  by  them,  and  to  be 
assured  that  the  method  is  followed  consistently  from  inventory  time  to 
inventory  time.  Depreciation  does  not  affect  the  items  of  Net  Sales  (5) 
or  of  "  Expense  "  (20-44),  but  it  does  affect  materially  the  accuracy  of 
the  profit  items  —  gross  and  net  (15,  17,  45,  51,  57). 

Three  main  methods  of  depreciation  in  use  in  the  retail  shoe  trade 
may  be  described  as  follows :  —  ^ 

(a)  The  arbitrary  percentage  method  depreciates  all  stock  by  a  certain 
fixed  percentage,  usually  some  multiple  of  five,  —  5  %,  10  %, 
15  %,  20  %,  at  each  inventory  time.  Though  this  is  arbitrary  and 
may  be  unjust  to  some  portions  of  the  stock,  it  has  the  advantage 
of  working  surely  without  being  affected  by  human  bias.  When 
inventory  is  taken  at  billed  cost  the  value  is  determined  auto- 
matically, that  is,  by  the  manufacturers'  or  wholesalers'  price 
to  the  retailer.  Then  the  appUcation  of  a  percentage  for  depre- 
ciation makes  the  paring  down  also  automatic. 

Just  what  percentage  should  be  employed  must  be  determined 
by  experience.  One  important  shoe  concern  with  large  retailing 
experience  employs  4  %  each  six  months.  The  Bureau  would  not 
advise  a  depreciation,  at  least  at  the  start,  of  less  than  10%. 

1  Concerns  which  customarily  take  cut-downs  or  carry  depreciated  stock  on  their 
books  at  the  depreciated  figures  during  between-inventory  periods — in  short,  concerns 
which  take  their  losses  from  day  to  day  on  stocks  that  are  not  selling  satisfactorily  — 
should  consider  this  fact  in  using  any  of  the  above  methods  of  depreciation.  See 
footnote  1,  page  18. 

3 


:5G?73 


(b)  The  age-of-slock  percentage  method  increases  the  percentage  of 
depreciation  with  the  age  of  stock  to  which  it  is  appHed.  For 
example,  stock  on  hand  more  than  one  year  is  depreciated  50  %, 
stock  on  hand  less  than  one  year  but  more  than  six  months  25  %, 
and  stock  on  hand  less  than  six  months  according  to  method  (a) 
or  method  (c). 

(c)  The  appraisal  method  is  based  on  the  estimated  market  value  at 
inventory.  In  theorj^  this  is  the  soundest  method  of  deprecia- 
tion. For  both  in  theory  and  in  fact  the  value  of  an  article  at 
any  time  is  what  it  will  bring  at  that  time.  Unfortunately  what 
an  unsold  shoe  will  bring  does  not  depend  upon  the  manager's 
or  stocktaker's  judgment,  for  he  may  be  too  optimistic  or  too 
pessimistic,  or  for  other  reasons  may  err.  However,  if  a  concern 
has  confidence  in  its  estimates  of  the  market  value  of  shoes  un- 
sold at  inventory  date,  it  may  proceed  in  the  following  way:  — 

Upon  its  inventory  books,  or  sheets,  provide  three  columns  1, 
2,  and  3  (the  first  two  to  be  filled  in  detail,  the  third  to  be  used 
for  test  purposes).     In  Column  1  enter  the  billed  cost  of  the  shoe, 
with  no  discount  deducted;  in  Column  2  enter  the  price  at  which 
it  is  thought  the  shoe  will  surely  sell.      Then  to  the  total  of  all 
items  in  Column  2  apply  the  percentage  of  average  gross  profit 
(including  discounts  taken)  for  the  last  two  years  and  deduct  the 
amount  thus  obtained  from  the  total  of  Column  2.     This  per- 
centage of  gross  profit  corresponds  to  that  of  Item  17  of  the 
Profit  and  Loss  Statement.      The  remainder  of  the  total  of 
Column  2  deducted  from  the  total  of  all  items  in  Column  1  will 
give  a  figure  of  depreciation  with  accuracy  corresponding  to 
the  accuracy  of  the  appraiser's  judgment.     Column  3  may  be 
used  for  testing  the  inventory  appraisal,  for  in  it  may  be  entered 
later  the  actual  price  at  which  the  shoe  did  sell. 
The  object  of  this  bulletin  is  to  make  clear  the  treatment  of  inventories 
and  depreciation  on  the  Profit  and  Loss  Statement  of  the  Harvard  Sys- 
Object  of  this   tem  of  Accounts  for  Shoe  Retailers,  and  to  show  how  the 
bulletin  Profit  and  Loss  Statement  is  derived  from  a  set  of  double 

entry  books  as  usualh^  kept.  Part  I  is  "  The  Treatment  of  Deprecia- 
tion on  the  Profit  and  Loss  Statement  of  the  Harvard  System  of  Ac- 
counts for  Shoe  Retailers,"  and  Part  II,  "  Instructions  for  Bookkeepers." 
About  specific  rates  of  depreciation  the  Bureau  will  say  only  a  little 
more  than  it  has  already  said  in  Bulletin  Number  2.  The  rapidity  of 
stock-turn  (average  inventory  at  billed  cost  divided  into  cost  of  goods 
sold  —  see  Bulletin  Number  1,  page  11)  has  a  distinct  relation  to  the 
importance  of  depreciation.     A  large  number  of  stock-turns  means  not 


only  that  the  average  inventorj'^  on  wliich  depreciation  is  allowed  is  in 
smaller  proportion  to  the  sales  than  when  the  stock-turns  are  fewer, 
but  also  that  the  average  age  of  the  stock  is  less,  and  this  operates  to 
reduce  the  ratio  of  depreciation  cost  to  sales.  This  point  has  been  well 
illustrated  in  the  Bureau's  study  of  the  retail  grocery  business,  where 
depreciation  has  already  been  found  to  be  a  comparatively  unimportant 
matter,  because  the  normal  number  of  stock-turns  annually  is  about 
ten  and  because  the  business  has  practically  no  style  or  size  risk.  In 
the  retail  shoe  business,  on  the  other  hand,  with  a  normal  number  of 
stock-turns  of  from  two  to  two  and  one-half  a  year  and  a  considerable 
degree  of  size  and  style  risk,  depreciation  is  of  much  more  importance. 

As  a  means  of  lessening  the  risk  of  loss  from  depreciation  caused  by 
an  accumulation  of  stock  and  overbuying,  the  Bureau  is  providing  the 
Harvard  System  of  Stock-keeping  for  Shoe  Retailers  (Bulletin  No.  5) 
l)ased  on  the  best  shoe  stock-keeping  practice  found  by  the  Bureau  and 
the  most  modern  methods  of  stock-keeping  in  general. 

Though  referring  specially  to  the  retail  shoe  business  some  principles 
of  depreciation  are  discussed  in  this  bulletin  of  general  application  to 
mercantile  businesses,  whether  wholesale  or  retail — principles  that  apply 
to  any  business  where  goods  are  Ijought  to  be  sold  rather  than  to  be 
used.      (See  especially  pages  6,  IS.) 


PART  I 

THE   TREATMENT   OF    DEPRECIATION    ON    THE    PROFIT 

AND  LOSS   STATEMENT  OF  THE  HARVARD 

SYSTEM   OF  ACCOUNTS   FOR  SHOE 

RETAILERS 

Depreciation  is  a  loss  in  value  due  to  wear  and  tear  and  the  passage 
of  time.  In  a  factory,  machines  and  tools  wear  out,  and  they  also 
become  less  valuable  as  they  become  more  old-fashioned. 
In  a  store,  stock  not  only  becomes  shop-worn,  but  also 
goes  out  of  date.  This  latter  loss  is  less  obvious  than  the  other  because 
it  is  a  loss  not  of  matter  but  of  value.  It  is,  however,  inevitable. 
Depreciation  is  taken  into  consideration  in  determining  profits  either 
directly,  with  measurement  in  separate  accounts,  or,  as  at  present  in 
the  majority  of  retail  shoe  stores,  indirectly  and  without  measurement. 
In  the  latter  case,  depreciation  is  taken  cither  by  a  reduction  of  inven- 
tory, without  showing  the  amount  of  reduction,  or  by  clearance  sales, 
which  reduce  the  gross  sales  and  consequently  gross  profit,  without 
showing  the  amount  of  reduction. 

Loss  from  depreciation  can  be  in  part  avoided  by  careful  buying, 
guided  by  carefully  kept  stock  records.  Even  then,  however,  the 
caprice  of  fashion,  with  the  passing  of  styles,  or  an  unforeseen  local 
change  in  sizes  demanded  by  the  dealer's  customers,  may  result  in  a 
"  bad  buy  "  —  an  "  unlucky  season." 

In  the  following  discussion  careful  attention  should  be  given  to  the 
difference  between  gross  and  net  inventories.  Gross  inventory  is  the 
Gross  and  net  total  merchandise  on  hand  at  billed  cost.  Net  inventorj'^ 
inventories  jg  ^j^g  gj-Qgg  inventory  with  the  allowance  for  depreciation 
and  discount  deducted.  In  that  its  Profit  and  Loss  Statement  uses 
both  gross  and  net  inventories  the  Harvard  System  can  be  called  a  gross 
and  net  system  as  is  further  shown  on  page  16.  A  specific  case  illus- 
trates the  simple  handling  of  these  matters.  Though  the  following 
figures  do  not  comprise  an  actual  record  of  any  one  shoe  business,  they 
are  based  on  many  such  records  in  the  possession  of  the  Bureau,  and 
may  be  regarded  as  not  in  the  least  theoretical  but  representing  actual 
experience  in  the  retail  shoe  trade. 

On  February  28,  1914,  at  the  end  of  the  first  six  months  of  a  new 
retail  shoe  business,  the  books  show  totals  wliich  are  arranged  on  the 
Profit  and  Loss  Statement  as  follows  (numbers  at  the  left  correspond 

6 


with  the  numbers  of  the  items  of  the  Harvard  System  of  Accounts  for 
Shoe  Retailers) :  — 

Statement  for  First  Period 

5  Net  Sales $20,862.05 

6  Inventory  Mdse.  Beginning  Period..  $00,000.00 

7  Pdhchases  Mdse.  at  Billed  Cost    . . .     28,836.00 

8  Freight,  Express  &  Cartage  on  Pur- 

chases of  Mdse 243.10 

9  Total  Merchandise  Cost $29,079.10 

10  Inventory  of  Mdse.  End  of  Period $15,145.38 

Less  11  Discount  on  Inv.  Mdse.   .  .  .    $393.78 

12  Depreciation  of  Mdse 1.475.16       1,868.94 

13  Net  Inventory  Mdse.  End  op  Period  13,276.44 

14  Net  Cost  of  Merchandise  Sold    15.802.66 

15  Profit  on  Merchandise    $5,059.39 

16  Cash  Discounts  taken  on  Purchases  Mdse.  749.74 

17  Gros.s  Profit  on  Merchandise $5,809.13 

44  Total  of  Expense  Statement    5,111.20 

45  Net  Profit  from  Merchandise  Operations $697.93 

56  Total  Interest 521.55 

57  Final  Surplus  for  the  Period    $176.38 

Item  11  is  obtained  by  dividing  the  Cash  Discounts  taken  (Item  16) 
$749.74  by  Purchases  (Item  7)  $28,836,  which  gives  .026,  or  2  6/10  %, 
as  the  average  discount  taken.  This  average,  therefore,  is  assumed  to 
apply  to  goods  still  on  hand  which  cost  less  than  billed  cost  by  the 
amount  of  this  discount.  Multiplying  the  gross  inventory  (Item  10) 
$15,145.38,  which  inventory  was  taken  at  billed  cost,  by  .026  gives 
$393.78  as  the  Discount  on  Inventory  of  Merchandise  (Item  11)  to  be 
deducted  from  the  billed  cost  value.  This  is  done  because  a  cash  dis- 
coimt  is  not  a  profit,  even  though  taken,  until  the  goods  on  which  it 
has  been  taken  have  been  sold.  If  this  were  not  done.  Item  16,  the 
total  cash  discounts  taken  on  the  purchases  of  $28,836,  would  be  reported 
as  a  total  addition  to  profit  even  though  on  $15,145.38  worth  of  that 
$28,836  not  even  the  cost  of  the  goods  has  been  recovered  to  say  nothing 
of  any  profit. 

As  the  business  is  new,  no  depreciation  has  yet  been  provided  for 
and  the  proprietors  wish  to  provide  a  10  %  allowance  for  depreciation 
on  the  unsold  goods  carried  over  at  the  end  of  the  season.  Subtracting 
the  Discount  on  Inventory,  $393.78,  from  the  gross  inventory,  $15,145.38, 
leaves  $14,751.60,  10%  of  which  gives  a  depreciation  of  $1,475.16 
(Item  12),  which  also  deducted  from  the  gross  inventory  leaves  the  Net 
Inventory  at  End  of  Period  (Item  13)  of  $13,276.44. 

This  is  obvious;  but  confusion  or  error  may  arise  when  later  Profit 
and  Loss  Statements  are  related  to  this  one.  Take  the  statement  at 
the  end  of  the  next  half-year,  August  31,  1914. 


-8 

statement  for  Second  Period 

5  Net  Sales $24,110.78 

6  Inventory  Mdse.  Beginning  Period..  $13,276.44 

7  Purchases  Mdse.  at  Billed  Cost  ....     17,259.20 

8  Freight,  Express  &  Cartage  on  Pur- 

chases OP  Mdse 149.30 

9  Total  Merchandise  Cost $30,684.94 

10  Inventory  of  Mdse.  End  of  Period $15,294.68 

Less  11  Discount  on  Inv.  Mdse.   .  .  .    $428.25 

12  Depreciation  of  Mdse 1,486.64       1,914.89 

13  Net  Inventory  Mdse.  End  of  Period  13,379.79 

14  Net  Cost  of  Merchandise  Sold    17,305.15 

15  Profit  on  Merchandise    $6,805.63 

16  Cash  Discounts  taken  on  Purchases  Mdse.  483.26 

17  Gross  Profit  on  Merchandise $7,288.89 

44  Total  of  Expense  Statement    5,666.03 

45  Net  Profit  from  Merchandise  Operations $1,622.86 

56  Total  Interest 482.22 

57  Final  Surplus  for  the  Period    $1,140.64 

In  the  same  way  as  before,  cash  discounts  taken,  $483.26,  divided 
by  purchases  (Item  7),  $17,259.20,  gives  the  average  rate  of  2.8%, 
which  apphed  to  the  gross  inventory  gives  a  Discount  on  Inventory 
(Item  11)  of  $428.25,  and  this  deducted  leaves  a  remainder  of  $14,866.43, 
the  depreciation  on  which,  if  continued  at  10%,  amounts  to  $1,486.64 
(Item  12),  leaving  a  net  inventory  (Item  13)  of  $13,379.79. 

It  may  be  stated  here  that  neither  the  arbitrary  percentage  method 
nor  the  percentage  10  as  employed  above  is  actually  recommended. 
On  the  contrary,  for  reasons  explained  on  pages  4  and  12,  the  Bureau 
recommends  the  appraisal  method  as  the  best.  Ten  per  cent  would 
probably  be  insufficient  depreciation  for  a  retail  shoe  business  largely 
of  a  specialty  nature,  and  possibly  would  be  too  much  for  one  largely 
staple.  The  arbitrary  percentage  method,  however,  besides  being  very 
common  in  the  retail  shoe  trade,  serves  better  than  the  other  methods 
for  purposes  of  explanation.  It  clearly  illustrates  both  principles  and 
misconceptions  about  mercantile  depreciation  which  apply  also  to  the 
other  methods  of  depreciation,  as  pointed  out  on  page  19. 

Returning  to  the  example,  it  is  most  important  to  note  that  the 
apparently  heavy  cost  for  depreciation  (Item  12)  of  $1,486.64  is  but  a 
Much  of  the  ^^^^  ^^^^  ^^  $11.48,  since  $1,475.16  of  the  allowance  was 
*^^^«fi*^'**'*'"  d  ^o^^i'^'i  '^y  t^^  depreciation  taken  at  the  first  inventory 
statement  (Item  12,  Profit  and  Loss  Statement,  page  7).  The  inclu- 
nom  n  on  y  ^^^^  ^j  ^j^^  latter  sum,  therefore,  is  in  one  sense  nominal, 
but  it  is  a  statistical  necessity  because  the  goods  are  again  inventoried 
at  billed  cost,  that  is,  the  first  10  %  taken  off  has  been  restored.  If  the 
merchandise  on  hand  at  the  first  inventory  had  been  recorded  at  billed 


cost  less  10  %  and  all  new  goods  received  since  that  inventory  likewise 
entered  with  a  value  of  billed  cost  less  10  %  (no  matter  at  what  price  or 
profit  they  sold),  then  it  would  never  be  necessary  to  take  subsequent 
allowances  of  10  %  for  depreciations  on  the  Profit  and  Loss  Statement. 
But  it  is  decidedly  important  for  business  purposes  to  know  the  billed 
cost  of  merchandise  on  hand,  and  so  inventories  are  taken  at  billed  cost 
each  time,  and  the  horizontal-percentage  reductions  are  taken  after- 
wards. Consequently  there  is  the  appearance  at  each  inventory  of  a 
heavy  depreciation  cost  when  really  the  depreciation  is  only  upon  the 
increase  of  stock  over  the  last  inventory,  in  this  case  $14,866.43  minus 
$14,751.60  (inventories  with  cash  discounts  deducted)  or  $114.83,  which 
at  10%  gives  $11.48  as  the  real  depreciation  cost  at  this  inventory. 

The  last  paragraph  contains  the  pith  of  the  whole  problem  of  depreci- 
ation in  mercantile  businesses.  It  is  the  point  that  the  Bureau  has 
The  Bith  of  found  most  difficult  to  make  clear  to  shoe  retailers, 
the  deprecia-  As  a  result  of  its  experience  the  Bureau  believes  the  fol- 
lowing to  be  the  most  effective  form  of  explanation.  The 
first  merchandise  inventory  of  this  new  business  with  discounts  deducted 
amounted  to  $14,751.60  (Item  10  of  the  first  statement  minus  Item  11). 
On  this  stock,  a  depreciation  of  10  %,  or  $1,475.16,  was  taken.  This  is  a 
depreciation  once  for  all  at  the  rate  of  10%  on  that  value  of  stock. 
The  stock  itself  is  changing  continually  but  on  a  value  of  stock  equiva- 
lent to  $14,751.60  a  depreciation  of  10%  has  been  taken  for  all  time. 
Subsequent  depreciations  need  to  be  taken  in  reality  on  increases  only 
of  stock  above  $14,751.60.  Conversely,  on  decreases  of  stock  below 
that  value,  the  original  depreciation  will  in  reaUty  be  reduced  if  the  same 
rate  of  depreciation  is  allowed.  This  is  what  automatically  happens 
in  any  mercantile  concern  taking  its  inventories  at  billed  cost  and 
employing  the  arbitrarj'^-percentage  method  of  depreciation,  which  is 
the  method  employed  in  this  case. 

A  concrete  table  will  make  clearer  the  point  that  concerns  which 
customarily  deduct  a  certain  percentage  from  their  inventories  for 
An  illustrative  depreciation  do  not  necessarily  increase  the  depreciation 
table  q£  those  inventories  each  time.      Take  three  successive 

inventories,  each  with  a  value  at  billed  cost  of  $10,000,  and  depreciate 
regularly  10  %  at  each  inventory:  — 


10 


Three  Successive  Inventories  of  the  Same  Value  at  Billed 
Cost  with  and  without  Depreciation  at  10% 


Inventories  at 
billed  cost 

Gross  Inventory  (without  de- 
preciation) 

Depreciation    on   each   inven-   q 
tory  at  10  % .  Each  inventory  at    o, 
billed  cost.  Really  depreciation   g 
on  first  inventory  only,   with    g 
nominal  depreciation  there-   f^ 
after.    Proper  for  merchandise     >■*■ 

Al 

_A 

0. 

V 
T3 

3  3 

c"3 
¥0 

^o 
II 

Depreciation     cumulative     at   q 
10%  —  the     paring     method,    o. 
Amount  of  last  depreciation  de-  g 
ducted  before  next  percentage    g 
is  deducted.       Proper  for  fix- 
tures,  but  not  for  merchandise   ^ 

Further 

explanation  of 

Column  B 

Bl 

1 

(U 

S  3 
a'o 

go 
II 

First  inventory 
Second  invcntorj- 

Third  inventory 

$10,000 
10,000 

10,000 

$1,000 
1,000 

1,000 

$9,000 
9,000 

9,000 

$1,000 
1,900 

2,710 

Previous  $1,000 
plus   new    10% 
of  last  net  in- 
ventory    (10% 
of  $9,000) 
Previous  $1,900 
plus    new    10% 
of  last  net  in- 
ventory    (10% 
of  $8,100) 

$9,000 
8,100 

7,290 

Difference  be- 
tween first  and 
third     inven- 
tories    

Difference  be- 
tween first  and 
third    deprecia- 
tions   

000 

000 

000 

$1,710 

$1,710 

Difference  between  inventories,  gross  and  net  Al  at  first  inventory  time,  $1,000 
"  "  "  «         «       «    Al   «  third        "  "         1,000 

«  a  a  a         «       «    gi    «   gjgt  «  «         1000 

"  "  «  «         «       «    Bl   «  tljjyd        «  «         2,710 


Column  A  represents  the  method  of  depreciation  that  is  employed 
when  a  business  regularly  deducts  a  certain  percentage  from  each  in- 
Summary  of  ventory  after  it  has  been  taken  at  billed  cost.  This 
column  shows  that  the  total  depreciation  for  three  in- 
ventories is  no  greater  than  the  first  depreciation  or,  in  other  words, 
that  no  new  depreciation  was  taken  after  the  first  inventory. 


11 

The  problem  has  been  simpHfied  here  by  assuming  an  imchanging 
inventory,  but  the  principle  holds  with  a  varying  inventory.  If,  for 
example,  the  inventory  increased  to  $12,000,  it  would  be  found  that  an 
additional  depreciation  of  $200  would  be  taken  as  a  cost  once  only, 
no  matter  how  many  subsequent  times  it  was  computed;  and,  simi- 
larly, if  the  inventory  decreased  to  $8,000,  a  reduction  of  depreciation 
of  $200  would  result  but  once  only. 

In  Column  B  of  the  table,  the  first  inventory  is  taken  as  a  per- 
manent stock  to  be  reduced  in  value  —  the  paring  method,  as  it  has 
been  called.  The  result  in  this  column  is  seen  to  be  depreciation  in 
three  inventories  of  $2,710  distributed  over  all  three,  as  contrasted  with 
a  depreciation  of  $1,000  at  the  first  inventory  and  none  additional 
for  the  succeeding  two  inventories  in  Column  A. 

Colunm  B  is  a  proper  method  of  depreciation  for  the  fixtures  of  a 
store,  which  are  for  use  and  not  for  sale,  but  not  for  the  merchandise 
which  is  passing  through  the  store.  There  is  not  a  "  turn-over  "  in 
fixtures  as  in  merchandise,  hence  this  steady  paring  method  of  Column  B 
applies  to  fixtures  as  they  tvear  out  in  the  same  way  that  it  applies  to 
the  equipment  of  a  factory. 

Column  A  represents  the  percentage  method  of  depreciation  as  it 
should  be  in  a  normally  operating  mercantile  business,  for  after  the 
Column  A  of  ^S^^S  of  the  first  few  months  of  the  first  stock  of  a  new 
the  table  the  business  the  average  age  of  stock  should  become  no  greater 
proper  method  -77,1  ■       ,  7  7  7  ,  . 

provided  there  is  at  least  one  stock-turn  between  each  two  in- 
ventories. For  it  can  be  assumed  that  in  the  long  run  newer  goods  take 
the  place  of  goods  sold  in  approximately  the  same  degree  that  goods  not 
sold  grow  older.  Businesses  not  conforming  to  this  rule  cannot  long  re- 
main going  concerns.  Therefore  the  depreciation  of  the  fii'st  few  months 
is  not  increased  except  as  stock  is  increased,  and  consequently  the  de- 
preciation allowance  is  not  increased  save  on  increases  of  stock,  and  is 
decreased  on  decreases  of  stock. 

Curiously,  many  shoe  retailers  who  have  employed  the  percentage 
method  of  Column  A  have  thought  that  they  were  allowing  for  a  greater 
Curious  mis-  depreciation.  When  they  allowed,  for  example,  10  %  a 
mSiy  ^shoe  °  y^ar  for  depreciation,  they  thought  that  they  were  making 
retailers  liberal  provision  and  were  gradually  reducing  their  valua- 

tion on  old  shoes  to  little  or  nothing.  Remembering  that  10  times  10 
is  100  they  have  beUeved  that  in  ten  years  they  have  depreciated  all  old 
stock  100  %,  or  to  no  value  at  all;  or,  in  other  words,  in  accord  with  the 
paring  method  of  Column  B.  They  have  not  noticed  that  new  stock 
constantly  takes  the  place  of  old  and  that  a  depreciation  taken  on  billed 
cost  is  in  reality  taken  only  once.  Applying  a  10  %  depreciation  suc- 
cessively to  a  $3  article  would  pare  it  to  these  successive  values,  $2.70, 


12 

$2.43,  $2.19,  etc.  This  is  what  some  dealers  think  they  are  doing  when 
they  apply  a  constant  percentage  year  after  year  to  billed  cost,  but 
many  of  them  never  get  below  $2.70  for  they  go  back  to  $3  at  each 
stock-taking  for  a  fresh  start.  This,  as  has  been  shown,  is  usually 
satisfactory.  With  stock  moving  fairly  well  the  paring  method  is 
seldom  necessary,  if  a  depreciation  percentage  for  the  whole  stock  is 
employed,  especially  when  the  accuracy  of  the  percentage  is  checked 
at  times  by  the  appraisal  method,  since  as  mentioned  on  page  4  in- 
sufficient depreciation  on  some  portions  of  the  merchandise  is  likely  to 
be  equalized  by  excessive  depreciation  on  other  portions.  When,  how- 
ever, stock  has  been  moving  slowly  for  several  months  the  percentage 
method  becomes  unreliable  and  resort  should  be  made  at  once  to  the 
appraisal  method.  The  age-of-stock  method  (juoted  on  page  4  is  in 
reality  a  paring  method,  since  it  employs  a  percentage  of  depreciation 
increasing  with  increasing  age  —  25  %  for  merchandise  more  than  six 
months  old  and  50  %  for  that  more  than  a  year  old  with  some  deprecia- 
tion on  merchandise  less  than  six  months  old.  Though  less  exact  than 
the  appraisal  method,  the  age-of-stock  method  is  to  be  commended  as 
safer  than  the  percentage  method  in  times  of  .slowly  moving  stock.  As 
to  the  appraisal  method  (see  also  page  4),  if  the  estimated  selling  prices 
of  Column  2  are  not  frequently  checked  l)y  the  actual  selling  prices  of 
Column  3  some  form  of  paring  method  may  well  be  employed.  But 
more  about  the  appraisal  method  will  be  found  hereafter  (page  19). 

A  return  now  to  the  shoe  business  under  consideration  shows  the 
situation  at  the  end  of  the  third  period,  February  28,  1915,  to  be  as 
follows:  — 

statement  for  Third  Period 

5  Net  Sales $27,075. 13 

6  Inventory  Mdse.  Beginning  Period..  $13,379.79 

7  PuRCHA.sEs  Mdse.  at  Billed  Cost    .  .  .     16,853.77 
S  Freight,  Express  &  Cartage  on  Pur- 
chases of  Mdse 139.48 

9  Total  Merchandise  Cost $30,373.04 

10  Inventory  of  Mdse.  End  of  Period $13,53.5.43 

Less  11  Discount  on  Inv.  Mdse.   .  .  .     $419.60 

12  Depreciation  of  Mdse 1,311.58       1,731.18 

13  Net  Inventory  Mdse.  End  of  Period  11,804.25 

14  Net  Cost  of  Merchandise  Sold 18,568.79 

15  Profit  on  Merchandise    $8,506.34 

16  Cash  Discounts  taken  on  Purchases  Mdse.  521.47 

17  Gross  Profit  on  Merchandise $9,027.81 

44  Total  of  Expense  Statement    6,227.28 

45  Net  Profit  from  Merchandise  Operations $2,800.53 

56  Total  Interest 622.73 

57  Final  Surplus  for  the  Period    $2,177.80 


13 

A  division  of  discounts  by  purchases,  as  before,  yields  an  average  dis- 
count taken  of  3.1  %,  whichjapplied  to  the  gross  inventory  gives  $419.60; 
this  deducted  from  the  inventory  leaves  $13,115.83,  which  with  a  de- 
preciation of  10  %  deducted  leaves  a  net  inventory  of  $11,804.25. 

Again,  although  an  apparently  heavy  depreciation  cost  of  $1,311.58 
appears  on  the  statement,  it  must  be  remembered  that  in  fact  this 
represents  no  real  additional  cost.  On  the  contrary,  it  represents  a 
decrease  of  $175.06  from  the  previous  depreciation  charge  of  $1,486.64. 
This  is  because  by  taking  the  inventory  at  billed  cost  the  preceding 
depreciation  is  restored,  just  as  the  $3  shoe  on  page  11  originally  depre- 
ciated to  $2.70  was  restored  to  $3. 

The  Profit  and  Loss  Statement  of  the  Harvard  System  of  Accounts 
for  Shoe  Retailers  is  on  neither  a  strictly  gross  nor  strictly  net  basis. 
It  does  not  deal  entirely  with  gross  inventories  or  entirely  with  net 
inventories  (see  also  page  6),  but  is  a  combination  of  both,  utilizing 
the  gross  and  net  inventories  so  as  to  show  the  billed  value,  the 
depreciation,  and  the  actual  values.  For  example.  Item  13  —  Net 
Inventory  of  Merchandise  at  End  of  Period  —  is  net,  and  is  carried 
as  Item  6  —  Inventory  of  Merchandise  at  Beginning  of  Period 
—  of  the  next  statement.  Items  6  and  13  then  are  net  figures,  but 
Item  10  —  Inventory  of  Merchandise  at  End  of  Period  ^  is  a  gross 
figure  from  which  the  succeeding  net  inventory  figure  is  obtained  by 
deducting  discount  and  depreciation  on  inventory.  Arranging  the  three 
preceding  statements  in  a  comparative  table  and  on  three  different 
bases  —  gross,  net,  and  combined  —  wiU  show  the  resulting  profit  to 
be  the  same  though  the  calculations  for  determining  it  are  different.  It 
will  furthermore  show  how  a  reduction  in  the  allowance  for  depreciation 
is  in  one  sense  a  gain,  just  as  an  increase  is  a  loss. 


14 


Item  of  A  Comparative  Table  of  the  Three  Statements 

P.  &  L. 

State- 
ment Net  Basis  Ist  —  Feb.  28,  1914 

5  Net  Sales $20,862.05 

6  Inventory  of  Mdse.  at  Beginning  of  Period    $00,000.00 

7  Purchases  of  Mdse.  at  Billed  Cost    28,836.00 

8  Freight,  Express  and  Cartage  on  Purchases   243.10 

9  Total  Mdse.  Cost $29,079.10 

13  Net  Inventory  of  Mdse.  at  End  of  Period 13,276.44 

14  Net  Cost  of  Mdse.  Sold    15,80J,66 

15  Profit  on  Mdse $5,059.39 

16  Cash  Discounts  Taken  on  Purchases  of  Mdse 749.74 

17  Gross  Profit  on  Mdse $5,809.13 

Gross  Basis 

5      Net  Sales $20,862.05 

0      Inventory  of  Mdse.  at  Beginning  of  Period  (Gro.ss)  $00,000.00 

7  Purchases  of  Mdse.  at  Billed  Cost    28,830.00 

8  Freight,  Express  and  Cartage  on  Purchases 243.10 

9  Total  Mdse.  Co.st .$29,079.10 

10  Inventory  (Gross)  of  Mdwo.  at  End  of  Period 15,145.38 

Gross  Cost  of  Mdse.  Sold $13,933.72 

11  Discount  on  Inventory  of  Mdse.,  plus 

12  Depreciation  of  Mdse 1,808.94 

14  Net  Cost  of  Mdse.  Sold    1.5,802.66 

15  Profit  on  Mdse $5,059.39 

16  Cash  Discounts  Taken  on  Purchases  of  Mdse 749.74 

17  Gross  Profit  on  Mdse $5,809.13 

Combined  Basis 
(Harvard  System  of  Accounts  for  Shoo  Retailers) 

5  Net  Sales $20,862.05 

6  Inventory  of  Mdse.  at  Beginning  of  Period    $00,000.00 

7  Purchases  of  Mdse.  at  Billed  Cost 28,836.00 

8  Freight,  Express  and  Cartage  on  Purchases 243.10 

9  Total  Mdse.  Cost    $29,079.10 

10       Inventory  of  Mdse.  at  End  of  Period $15,145.38 

Less  11  Discount  on  Inventory  of  Mdse $393.78 

12  Depreciation  of  Mdse 1,475.16         1,868.94 

13  Net  Inventory  of  Mdse.  at  End  of  Period  13,276.44 

14  Net  Cost  of  Mdse.  Sold    15,802.66 

15  Profit  on  Mdse $5,059.39 

16  Cash  Discounts  Taken  on  Purchases   ....  749.74 

17  Gross  Profit  on  Mdse $5,809.13 

•  Increase  over  the  first  depreciation  and  discount,  and  hence  an  increase  in  cost. 


15 


ON  Three  Bases  —  Net,  Gross,  and  Combined 


2d  —  Aug.  31,  1914 


3d  —  Feb.  28,  1915 


$24,110.78 

$27,075.13 

$13,270.44 

$13,379.79 

17,259.20 

16,853.77 

149.30 

139.48 

$30,684.94 

$30,373.04 

13,379.79 

11,804.25 

17,305.15 

18,568.79 

$6,805.63 

$8,506.34 

483.26 

521.47 

$7,288.89 

$9,027.81 

$24,110.78 

$27,075.13 

$15,145.38 

$15,294.68 

17,259.20 

16,853.77 

149.30 

139.48 

$32,553.88 

$32,287.93 

15,294.68 

13,535.43 

$17,259.20 

$18,752.50 

45.95  ' 

183.71  « 

17,305.15 

18,568.79 

$6,805.63 

$8,506.34 

483.26 

521.47 

$7,288.79 

$9,027.81 

$24,110.78 


$27,075.13 


$13,276.44 

17,259.20 

149.30 

$15,294.68 
$428.25 
1,486.64       1,914.89 


$30,684.94 


13.379.79 


17,305.15 

$6,805.63 

483.26 

$7,288.89 


$13,379.79 

16,853.77 

139.48 

$13,535.43 
$419.60 
1,311.58       1,731.18 


$30,373.04 


11,804.25 


18,568.79 

$8,506.34 

521.47 

$9,027.81 


*  Decrease  from  the  second  depreciation  and  discount,  and  hence  a  reduction  in  cost. 


16 

The  result  of  the  three  plans  is  the  same.  The  difference  Ues  wholly 
in  the  explanation  of  the  profit.  The  net  basis  shows  profit  on  mer- 
Net  basis  and  chandise  figures  as  given  without  any  book  record  of  dis- 
gross  basis  count  and  depreciation  on  inventory,  the  record  of  these 
items  appearing  on  the  inventory  sheets  only.  On  the  gross  basis, 
depreciation  appears  at  first  when  actually  taken,  and  then  on  the 
difference  only  between  that  first  depreciation  and  subsequent  depre- 
ciations as  needed  by  the  differences  in  inventories.  At  the  second 
inventory  there  was  an  increase  in  stock,  hence  an  increase  in  deprecia- 
tion represented  by  an  addition  to  the  previous  depreciation.  This 
was  equivalent  to  an  increase  in  cost  and  a  consequent  decrease  in 
profit.  At  the  third  inventory  just  the  reverse  occurred.  There  was 
a  decrease  in  inventory,  hence  a  decrease  in  depreciation  represented 
by  a  subtraction  from  the  previous  depreciation.  This  is  equivalent  to 
a  decrease  in  cost,  and  a  consequent  increase  in  profit. 

On  the  combined  basis  plan,  which  is  that  of  the  Harvard  System  of 

Accounts  for  Shoe  Retailers,  a  combination  of  the  gross  and  the  net  basis 

Combined        is  employed.     This  gives  valuable  records  of  actual  and 

basis  is  that  of  -ij  •   j.-        e  j.        j  r  i. 

the  Harvard     nommal  depreciation  for  present  and  future  comparison. 

Acccomts^for  ^^  "^^^  ^^®  ^^^  beginning  inventory  brought  over  from  the 
Shoe  RetaUers  preceding  inventory,  and  thus  gets  the  cost  of  merchandise 
correct  at  the  start;  and  then,  by  using  the  gross  inventory  at  the  end, 
it  shows  both  the  depreciation  for  statistical  purposes  and  the  net  in- 
ventory for  the  balance  sheet.  What  appeared  under  the  gross  basis 
plan  to  be  a  gain  through  depreciation  appears  under  this  plan  where 
it  really  belongs,  in  the  merchandise  account.  Merchandise  really 
worth  $13,379.79  is  charged  up  at  that  figure  to  the  merchandise  account 
(see  "  Merchandise  "  account.  Part  II,  page  30),  and  not  at  $15,294.68, 
as  it  was  on  the  gross  basis  plan. 

In  other  words,  the  difference  is  in  the  treatment  of  the  inventory  at 
beginning  and  of  depreciation  shown.  The  gross  basis  plan  uses  the 
undepreciated  figure  for  inventory  at  the  beginning,  while  the  Harvard 
plan  uses  the  depreciated  figure  at  the  beginning,  but  the  gross  basis  plan 
charges  depreciation  as  a  cost  on  increase  of  inventory  only,  whereas  the 
Harvard  plan  shows  depreciation  on  the  entire  inventory;  and  the  result 
is  the  same  under  either  plan,  as  the  following  illustration  for  calculat- 
ing the  Net  Cost  of  Merchandise  Sold  (Item  14)  for  the  second  period 
shows:  — 


17 


Calculation  of  Net  Cost  of  Merchandise  Sold  (Item  14)  for 
THE  Second  Period 

Combined  basis  plan 
(Harvard  System  of  Accounts  for  Shoe 
Gross  basis  plan  Item  Retailers) 

Inventory    at    Beginning  6       Inventory    at     Beginning 

(gross) $15,145.38  (net)  already  depreciated  $13,276.44 

Purchases  of  Merchandise    .     17,259.20  7       Purchases  of  Merchandise     17,259.20 

Freight,  Express  &  Cartage  8       Freight.Express  &  Cartage 

on  Purchases 149.30  on  Purchases 149.30 

Discount  on  increase  in  in-  11       Discounton  Inventory  (en- 

ventory  (increase  only) .  .  .  34.47  tire) 428.25 

Depreciation  on  increase  in  12       Depreciation  of  Inventory 

inventory  (increase  only)    .  11.48  (entire) 1,486.64 

$32,599.83  $32,599.83 

Less:    Inventory  at  End  of  10       Less:  Inventory  at  End  of 

Period  (gross) 15,294.68  Period  (gross) 15,294.68 

Net  Cost  of  Mdse.  Sold   .  .  .   $17,305.15  14       Net  Cost  of  Mdse.  Sold .  .  .   $17,305.15 

A  summary  of  this  whole  discussion  of  depreciation  in  mercantile 
businesses  is:^  (1)  After  an  allowance  for  depreciation  has  once  been 
adequately  made,  so  long  as  stock  is  of  the  same  average 
age  and  of  the  same  value  at  billed  cost  no  further  allow- 
ance becomes  necessary  —  for  the  stock  is  maintained  at  the  same  ratio 
of  cost  to  value,  and  the  item  of  depreciation  on  the  statement  is  not  a 
cost  but  a  mere  deduction  for  what  has  been  entered,  for  convenience, 
above  actual  value,  in  the  gross  inventory.  (2)  If  stock  has  grown 
older,  a  higher  rate  of  depreciation  should  be  used,  and  the  increase 
wUl  be  a  new  cost.  (3)  If,  on  the  other  hand,  the  stock  is  less  old,  a 
smaller  percentage  of  depreciation  wUl  be  required,  and  the  decrease 
wUl  be  a  gain.  In  this  case,  the  profit  of  the  business  is  partly  in  what 
was  received  from  sales  and  partly  in  a  greater  value  on  the  shelves 
for  the  same  billed  cost  —  a  less  depreciated  value.  (4)  If  the  stock 
has  increased,  more  goods  are  depreciating,  and  unless  the  increase  was 
made  at  the  end  of  the  year  (in  which  case  the  average  age  will  be  less 
and  the  preceding  case  will  apply),  the  same  percentage  as  before  will  be 
used;  but  since  it  will  be  used  on  a  larger  amount,  the  depreciation  will 
be  more  and  the  iucrease  will  be  a  new  cost  or  loss,  taken  out  of  the 
merchandise  inventory.  (5)  If  the  stock  has  decreased,  the  old  per- 
centage appUed  to  a  small  stock  will  give  smaller  depreciation,  and  the 
difference  will  be  a  gain  —  reaUzed  through  a  lower  cost  of  merchandise 
sold. 


18 


If,  therefore,  as  has  been  seen,  depreciation  in  a  mercantile  busi- 
ness operates  most  heavily  in  the  first  few  months  of  that  business,  then 
Depreciation  a  fairly  high  percentage  of  depreciation  on  the  first  inven- 
heavy'at' first;  tory  and  on  subsequent  increases  only,  over  the  value  of 
light  thereafter  that  inventory  is  in  accord  with  the  facts.  The  figures  in 
the  table  on  pages  14  and  15  reflect  these  facts,  for  on  the  first  statement 
the  gross  profit  is  seen  to  be  only  27.8  %  of  the  net  sales,  increasing  in 
the  second  and  third  statements  to  30.2  %  and  33.3  %  respectively.' 
Furthermore,  in  some  ways  in  the  first  year  of  any  business  a  higher 
rate  of  depreciation  can  be  afforded  since  no  old  stock  is  carried  into 
the  business  and  hence,  as  only  new  goods  are  to  be  sold,  there  will  be 
normally  fewer  mark-downs.^  So  stock  carried  over  for  the  first  time 
into  the  next  season  should  be  well  dei)reciated.  The  periodical  addi- 
tional cost  of  depreciation  thereafter  will  be  small,  as  only  increases  in 

'  This  increase  in  the  rate  of  profit  is  also  due  to  a  decrease  in  the  ratio  of  total 
expense  and  to  an  increase  in  the  rate  of  stock-turn  from  2.08  to  2.0  times  annually. 
The  significance  of  stock-turn  in  connection  with  depreciation  has  already  been  noted 
(page  4). 

s  Mark-downs  frequently  represent  depreciation  taken  between  inventories,  and 
do  not  differ  in  principle  from  depreciation  allowed  at  inventory  time  to  which  the  pre- 
ceding discussion  has  been  confined.  A  memorandum  of  mark-downs  can  be  kept  and 
the  totals  at  inventory  treated  as  Columns  1,  2,  and  3  of  the  appraisal  method  are 
treated  (see  pages  4  and  12).  In  fact,  mark-downs  often  are  an  application  of  the  ap- 
praisal method  between  inventories.  If,  for  example,  a  shoe  costing  $2,  is  marked  up 
to  $3  (33$%),  and  then  marked  down  to  $2.50  and  sold,  the  mark-down  price  of  J2.50 
reduced  by  the  average  gross  profit  for  the  business,  say  30%,  or  75  cents,  would  be 
deducted  from  the  cost,  giving  a  new  cost  after  depreciation  of  $1.75,  which  leaves  a 
depreciation  of  25  cents  ($2  minus  $1.75)  or  \2\%  on  the  original  billed  cost.  The 
record  would  stand :  — 


Cost 

Sell 

Mark-up 
% 

Marked  down 
between  inventories 
to,  or  appraised  at 
inventory  time  at 

Marked  down 

price  reduced  by 

average  gross 

profit  of  30% 

Depreciation 

on  original 

cost 

$2 

13 

33i 

$2.50 

$1.75 

$0.25=  12i% 

Under  the  arbitrary  percentage  method  of  depreciation  with  a  percentage  of  10  this 
pair  of  shoes  would  have  been  reduced  from  $2  to  $1.80,  giving  on  this  particular 
pair,  according  to  the  appraisal  method,  a  depreciation  insufficient  by  2J%.  The 
selling  of  the  shoes  between  inventories  at  the  mark-down  price  will  be  a  test  of  the 
mark-down  value,  just  as  entries  in  Column  3  of  the  appraisal  method  should  be  a 
test  of  the  estimated  values  of  shoes  unsold  at  inventory  time.  If  the  above  pair  of 
shoes  were  unsold  at  stock-taking  it  might  be  inventoried  at  billed  cost  ($2)  and  de- 
preciated by  the  flat  percentage  of,  say  10,  or  remain  at  the  mark-down  figure  and  be 
reduced  by  the  average  gross  profit,  or  be  classified  by  age  and  depreciated  accord- 
ingly —  depending  on  which  of  the  three  methods  of  depreciation  is  employed.  These 
are  described  in  Bulletin  Number  2,  and  in  this  bulletin  on  pages  3  and  4. 


19 

value  or  in  average  age  call  for  new  allowances  for  depreciation.  This 
is  conservative  and  correct  and  makes  a  solid  foundation  for  a  dealer's 
business. 

All  the  previous  discussion  and  examples  have  been  based  on  the 
first  of  the  three  methods  of  depreciation  —  (a)  arbitrary  -percentage 
Other  methods  "*^^'^o^  (^^e  page  3).  The  other  methods  —  (6)  age-of- 
of  depreciation  stock  percentage  method,  and  (c)  appraisal  method  (see 
do  not  change  'T  ",  ,  ,  •        i  rn,^  , 

the  preceding  page  4)  — would  work  out  m  the  same  way.      Ihe  only 

iscussion  difference  would  be  in  the  method  of  securing  the  figure 
of  depreciation,  for  the  treatment  of  that  figure,  once  secured,  would 
be  the  same. 

As  a  matter  of  fact,  the  appraisal  method  if  not  employed  regularly 
should  certainly  be  employed  occasionally,  to  see  that  the  percentage  of 
depreciation  customarily  used  corresponds  with  the  facts  and  to  pro- 
vide for  extraordinary  depreciation.  For  example,  certain  portions  of 
the  stock  may  accumulate  broken  Unes  and  end  sizes  to  such  a  degree 
that  the  ordinary  percentage  rate  of  depreciation  can  by  no  means  cover 
the  actual  depreciation,  and  so  a  fair  appraisal  should  be  made.  Further- 
more, it  should  again  be  emphasized  that  this  fair  appraisal  should  be 
tested  by  frequent  comparisons  with  records  of  actual  selling  prices  of 
pairs  appraised.  Column  3  of  the  appraisal  method  (see  page  4  —  c) 
is  provided  for  these  test  comparisons  (see  also  footnote  to  page  18). 

Practically  all  conditions  and  all  common  methods  of  depreciation 
have  now  been  discussed  in  connection  with  the  Profit  and  Loss  State- 
Remainder  of  ment  of  the  Harvard  System  of  Accounts  for  Shoe  Retailers, 
tains  double  For  shoe  businesses  keeping  very  simple  accounts  this  is 
kee^^in^""*^'  probably  the  only  treatment  of  depreciation  required  but 
Instructions  unless  these  figures  are  incorporated  on  the  books  it  will  be 
necessary  to  preserve  all  inventory  sheets.  For  those  wishing  to  enter 
these  details  on  the  general  ledger  an  outline  of  double  entry  method  is 
given  in  Part  11  for  the  three  statements  already  considered. 


PART  II 
INSTRUCTIONS   FOR   BOOKKEEPERS 

This  second  part  shows  the  ledger  accounts  for  the  three  Profit  and 
Loss  Statements  discussed  in  Part  I,  with  special  reference  to  the  com- 
bined basis  method  of  treating  inventories  and  depreciation.  It  also 
illustrates  in  a  general  way  how  the  Profit  and  Loss  Statement  of  the 
Harvard  System  of  Accounts  for  Shoe  Retailers  is  drawn  from  the  books. 

The  treatment  of  the  accounts  is  in  accordance  with  double  entry 
bookkeeping,  universally  recognized  as  the  proper  method.  The  ordi- 
nary ledger  accounts  for  merchandise  transactions  are  "  Purchases," 
"  Sales,"  "  Merchandise,"  "  Cash  Discounts,"  "  Freight,  etc.,"  "  In- 
ventory," and  "  Profit  and  Loss."  These  accounts  give  all  the  infor- 
mation necessary  for  making  up  that  division  of  the  Profit  and  Loss 
Statement  entitled  Merchandise  Statement.  So  far  as  the  treatment 
of  inventories  and  depreciation  is  concerned,  only  those  accounts  in- 
volving merchandise  items  need  to  be  considered,  but  since  other 
main  divisions  of  the  Profit  and  Loss  Statement,  such  as  Expense 
Statement,  Other  Business  Profits  or  Losses,  and  Application  of  Total 
Operating  Net  Profit,  need  consideration  in  order  to  show  the  net 
results  of  the  operation  of  the  store  for  each  period,  a  "  Total  Expense  " 
account  and  a  "  Total  Interest  "  account  have  been  included.  This 
"  Total  Expense  "  account  corresponds  to  Item  44,  Profit  and  Loss 
Statement,  page  7,  and  represents  the  total  of  the  various  expense 
accounts.  For  brevity,  since  this  explanation  is  concerned  primarily 
with  the  merchandise  accounts,  "  Total  Expense  "  only  is  shown  here, 
in  place  of  the  separate  expense  accounts  which  would  appear  on  the 
ledger.  The  "  Total  Interest  "  account  represents  Item  56,  Total 
Interest  and  Dividends,  of  the  Profit  and  Loss  Statement.  The 
"  Total  Expense  "  accomit  and  the  "  Total  Interest  "  account  are 
closed  into  the  "  Profit  and  Loss  "  account  on  the  books,  the  final 
balance  of  which  is  Final  Surplus  (or  Deficit)  for  the  Period,  Item  57, 
Profit  and  Loss  Statement,  page  7. 

Since  no  balance  from  a  previous  period  is  brought  over  into  this 
"  Profit  and  Loss  "  account,  and  since  the  losses,  costs,  and  expense 
appearing  on  the  debit  side  and  the  gains  and  income  on  the  credit  side 
belong  to  that  period  alone,  the  final  balance  closed  to  "  Surplus  " 
represents  the  net  results  of  the  business  for  the  single  period  in  question. 

20 


21 

In  order  to  make  clearer  the  relation  which  the  books  bear  to  this 
form  of  Profit  and  Loss  Statement,  the  figures  used  in  these  accounts 
are  identical  with  the  figures  used  on  the  Profit  and  Loss  Statement  for 
the  corresponding  periods,  pages  7,  8,  and  12,  Part  L 

The  difference  between  "  Profit  and  Loss  "  account,  as  it  appears  on 
the  books,  and  the  Profit  and  Loss  Slatement  of  the  Harvard  System 
of  Accounts  for  Shoe  Retailers  should  be  noted.  The  "  Profit  and  Loss  " 
account  on  the  books  is  an  integral  part  of  the  bookkeeping  system 
and  is  used  chiefly  at  the  close  of  a  period  to  bring  together  into  one 
book  account  all  profit  and  loss  items  from  other  accounts,  thus  caus- 
ing these  accounts  to  balance  and  show  in  the  "  Profit  and  Loss  " 
account  the  final  balance  of  gains  or  losses,  which  corresponds  to  Item  57, 
of  the  Profit  and  Loss  Statement,  Final  Surplus  (or  Deficit),  and  for  each 
period  is  ultimately  to  be  transferred  from  the  "  Profit  and  Loss  " 
account  to  the  "  Surplus  "  account  on  the  books. 

The  "  Profit  and  Loss  "  account,  then,  is  a  ledger  account  for  grouping 
all  loss  and  gain  items,  which  to  a  certain  degree  offset  each  other  and 
give  a  final  balance  of  loss  or  gain  as  represented  by  the  balance  of  this 
account  after  closing,  which  in  these  accounts  is  closed  to  "  Surplus  " 
account. 

The  Profit  and  Loss  Statement,  on  the  other  hand,  is  drawn  from  the 
ledger  accounts  at  inventory  time,  to  show,  by  a  logical  grouping  and 
analysis,  the  results  of  the  operations  of  the  period.  Its  final  figure  is 
the  Final  Surplus  (or  Deficit)  for  the  Period,  Item  57,  which  is  identical 
with  the  final  balance  of  the  "  Profit  and  Loss  "  account. 

The  exact  entries  to  each  of  these  book  accounts  as  represented  by 
the  items  of  the  Profit  and  Loss  Statement  are  fully  explained  in  Bulletin 
Number  2.  In  brief,  the  "Purchases"  and  the  "Sales"  accounts  are 
current  accounts,  all  merchandise  purchases  being  charged  to  "  Pur- 
chases "  currently,  and  all  sales,  both  cash  and  credit,  being  credited 
to  the  account  "  Sales."  "  Cash  Discounts,"  "  Freight,  etc.,"  and 
"Total  Expense"  are  also  current  accounts,  but  "Inventory,"  "Mer- 
chandise," and  "  Profit  and  Loss  "  accounts  wiU  ordinarily  be  used 
only  upon  closing  the  books. 

To  avoid  complication,  the  matter  of  Returns  and  Allowances  which 
go  to  reduce  sales  has  been  omitted  here  and  it  is  assumed  that  the 
sales  figures  used  here  are  Net  Sales.  If  accounts  for  Returns  and 
Allowances  are  kept  they  will  be  closed  into  the  "  Sales  "  account, 
thus  reducing  the  gross  sales  figure,  and  giving  Net  Sales.  For  example, 
"  Returns  "  account  is  currently  debited  with  goods  which  have  been 
sold  but  are  subsequently  returned,  the  customer,  or  cash,  being  credited 
according  as  the  original  sale  was  a  credit  or  a  cash  sale.     At  the  close 


22 


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24 

of  the  period  this  account  "  Returns  "  is  credited  and  the  "  Sales  " 
account  debited  for  the  total  returns  for  the  entire  period.  The  credit 
balance  of  "  Sales  "  after  "  Returns  "  and  "  Allowances  "  have  been 
closed  into  it,  is  Net  Sales,  Item  5,  of  the  Profit  and  Loss  Statement. 

It  is  assumed  that  this  is  a  new  business  which  began  with  a  working 
capital  of  -SI 5,000,  borrowed  on  notes,  represented  on  the  ledger  by  the 
"  Notes  Payalile  "  account.  "  Accounts  Payable  "  is  a  controlling 
account  representing  the  total  owed  to  all  indi\adual  creditors  for 
goods  purchased.  The  working  capital  supplied  by  "  Notes  Payable  " 
enables  the  business  to  pay  promptly  and  take  cash  discounts  as 
offered.  At  the  close  of  each  period,  part  of  the  cash  balance  is  applied 
on  the  notes  payable,  thus  reducing  this  liability.  All  sales  are  for 
cash,  the  business  being  on  a  strictly  cash  basis. 

At  the  end  of  the  first  period,  February  28,  1914,  before  any  ac- 
counts were  closed,  the  books  show  the  accounts  mentioned,  as  on 
page  22.1 

A  "  Merchandise  "  account  is  opened,  and  into  it  is  closed  "  Pur- 
chases." The  "  Merchandise  "  account  is  then  credited  with  "  In- 
ventory 2/28/14,"  an  account  of  the  same  name  being  opened.  The 
balance  of  the  "  Merchandise  "  account  is  then  closed  into  "  Profit  and 
Loss  "  as  part  of  the  cost  of  goods  sold.  "  Inventory  2/28/14  "  is  next 
credited  with  Discount  on  Inventory,  and  with  Depreciation  of  Inven- 
tory, Items  11  and  12,  Profit  and  Loss  Statement,  page  7,  —both  of 
these,  with  "  Freight,  etc.,"  being  charged  to  the  "  Profit  and  Loss  " 
account.  The  total  of  the  debits  to  this  account  at  this  point  repre- 
sents the  Net  Cost  of  Merchandise  Sold,  Item  14,  Profit  and  Loss 
Statement,  page  7.  "  Sales  "  and  "  Cash  Discounts  "  are  then  closed 
into  "  Profit  and  Loss  "  —  that  is,  they  are  debited  and  "  Profit  and 
Loss  "  is  credited  for  their  balances.  The  Gross  Profit  on  Merchan- 
dise, Item  17,  Profit  and  Loss  Statement,  can  then  be  found  and  proved 
with  the  Statement  by  deducting  the  total  of  the  first  four  debit  items 
of  the  "  Profit  and  Loss  "  account  from  the  total  credits  to  the  "  Profit 
and  Loss  "  account,  that  is,  "  Sales,"  and  "  Cash  Discounts."  "  Total 
Expense  "  (Item  44),  and  "  Total  Interest  "  (Item  56),  are  then  closed 
into  "  Profit  and  Loss  "  account,  the  balance  of  which  is  Item  57, 

•  The  numbers  before  the  titles  of  these  accounts  correspond  to  the  numbers  of  the 
items  on  the  Profit  and  Loss  Statement,  page  7,  and  accounts  so  numbered  will  be 
seen  to  contain  the  same  figures  as  similarly  numbered  items  of  the  Profit  and  Loss 
Statement,  page  7.  These  accounts  are  kept  in  double  entry  and  the  word  before  the 
figures  for  amounts  indicates  the  name  of  the  account  in  which  the  other  side  of  the  entry 
will  be  found:  e.  g.,  in  the  "  Sales  "  account,  credit  side,  appears  "  Cash,  $20,862.05  "; 
"  Cash  "  means  that  the  debit  corresponding  to  this  credit  to  the  "  Sales  "  account 
will  be  found  in  the  "  Cash  "  account,  debit  side. 


25 


Final  Surplus  for  the  Period,  Profit  and  Loss  Statement,  page  7,  and  is 
transferred  to  the  "  Surplus  "  account,  as  explained  on  page  20. 
After  closing,  the  trial  balance  of  these  accounts  is  as  follows:  — 

Trial  Balance,  First  Period,  Feb.  28,  1914 

Cash $399.94         Notes  Pay $13,500.00 

Inv.  2/28/14 13.276.44         Surplus 176.38 

$13,676.38  $13,676.38 

The  balance  of  "  Inventory  2/28/14  "  ($13,276.44)  is  now  Item  13, 
Profit  and  Loss  Statement,  page  7,  that  is.  Net  Inventory  at  End  of 
Period,  and  will  be  Item  6,  Inventory  at  Beginning  of  Period,  at  the 
beginning  of  the  second  period. 

The  books  have  now  been  closed  and  the  accounts  show  the  figures 
necessary  to  make  up  the  Profit  and  Loss  Statement  of  the  Harvard 
System  of  Accounts  for  Shoe  Retailers,  as  shown  on  page  7.  The  follow- 
ing table  shows  how  this  statement  is  derived  from  these  accounts :  — 


Profit  and  Loss  Statement  Items  Figures 

5  Net  Sales $20,862.05 

6  Inventory  .'Vt  Beginning  of  Period  00,000.00 

7  PURCH.\SES   AT   BiLLED    CosT     28,836.00 

8  Freight,  Express  &  CARTA(iE  ON  PoR.       243.10 

9  Total  Merchandise  Cost 29,079.10 

10  Inventory  at  End  of  Period 15,145.38 

11  Discount  on  Inventory   393.78 

12  Depreciation  of  Inventory 1,475.16 

13  Net  Inventory  at  End  of  Period  13,276.44 

14  Net  Cost  of  Merchandise  Sold 15,802.66 

15  Profit  on  Merchandise 5,059.39 

16  Cash   Discounts   Taken   on   Poh.  749.74 

17  Gross  Profit  on  Merchandise   5,809.13 

44  Total  of  Expense  Statement    5,111.20 

56  Total  interest 521.55 

57  Final  Surplus  for  the  Period    176,38 


Source 
"  Sales  "  account 

"  Purchases  "  account 

"  Freight,  etc."  account 

Sum  of  Items  6,  7,  and  8 

"  Inventory  2/28/14  "  account 


Item  9  minus  Item  13 

Item  5  minus  Item  14 

"  Cash  Discounts  "  account 

Item  15  plus  Item  16 

"  Total  Expense  "  account 

"  Total  Interest  "  account 

"  Surplus  "  account 


At  the  beginning  of  the  second  period,  the  balances  of  the  accounts 
on  the  ledger,  according  to  the  trial  balance  are:  — 


Inventory  2/28/14 
Balance  $13,276.44 

Notes  Payable 

Balance  $13,.500.00 


Cash 


Balance  $399.94 


Surplus 
P.  &  L.  2/28/14  $176.38 


This  "  Inventory  2/28/14  "  balance  was  the  gross  Inventory  at  the 
End  of  the  first  period  less  Discount  on  Inventory  and  Depreciation  of 


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28 

Inventory;  that  is,  the  Net  Inventory  at  the  End  of  the  first  period, 
Item  13,  Profit  and  Loss  Statement,  page  7.  According  to  the  com- 
t)ined  basis  method  of  the  Harvard  System  of  Accounts  for  Shoe  Re- 
tailers this  Net  Inventory  at  the  End  of  the  first  period  now  becomes 
Inventory  at  the  Beginning  of  the  second  period,  Item  G,  Profit  and  Loss 
Statement,  page  8,  but  on  the  ledger  it  is  not  necessary  to  open  a 
new  account  to  recoi'd  this  fact,  for,  since  the  Net  Inventory  at  the  End 
of  the  first  period  and  the  Inventory  at  the  Beginning  of  the  second 
period  are  identical,  this  "  Inventory  2/28/14  "  balance  is  closed  di- 
rectly into  the  "  Merchandise  "  account  of  the  second  period. 

At  the  end  of  the  second  period,  after  the  closing  of  the  "  Inventory 
2/28/14  "  balance  into  "  Merchandise  "  account,  but  before  the  closing 
of  the  other  accounts,  the  books  will  look  as  on  pages  26  and  27.  The 
closing  process  is  the  same  as  for  the  first  period,  and  is  explained  in 
detail  on  page  24. 

How  this  treatment  of  Inventories,  Discount  on  Inventory,  and 
Depreciation  of  Inventory  furnishes  figures  which  accord  with  the 
combined  basis  as  advocated  by  the  Harvard  System  of  Accounts,  is 
apparent.  From  page  14  it  will  be  seen  that  this  combined  method 
shows  on  the  Profit  and  Loss  Statement,  as  Item  6,  the  Inventory 
at  the  Beginning  of  the  Period;  Item  10,  Inventory  at  the  End  of  the 
Period,  reduced  by  Item  11,  Discount  on  Inventory,  and  Item  12, 
Depreciation  of  Inventory,  gives  Item  13,  Net  Inventory  at  End  of 
Period.  This  Net  Inventory  at  the  End  of  Period,  Item  13,  of  one 
period  becomes  the  Inventory  at  the  Beginning  of  the  Period,  Item  6, 
of  the  following  period.  On  the  books  this  fact  is  recorded  as  follows:  — 
In  the  first  period,  the  balance  of  "  Inventory  2/28/14  "  after  deduct- 
ing discount  and  depreciation  of  inventory  was  $13,276.44  which  figure 
agrees  with  Item  13,  Net  Inventory  at  the  End  of  the  first  period,  page  7, 
Profit  and  Loss  Statement.  At  the  beginning  of  the  second  period  this 
inventory  balance  of  $13,276.44  was  closed  into  the  "  Merchandise  " 
account  of  the  second  period — this  debit  to  "  Merchandise"  of  $13,276.44 
corresponding  to  Item  6,  Inventory  at  Beginning  of  the  second  period. 
Profit  and  Loss  Statement,  page  8.  The  inventory  at  the  end  of  the 
second  period  was  $15,294.68.  This  amount  was  credited  to  "  Mer- 
chandise "  and  charged  to  "  Inventory  8/31/14,"  this  debit  correspond- 
ing to  Item  10,  Inventory  at  End  of  Period,  Profit  and  Loss  Statement, 
page  8.  This  "  Inventory  8/31/14  "  was  then  reduced  by  credits  of 
$428.25  for  Discount  on  Inventory,  and  $1,486.64  for  Depreciation  of 
Inventory,  both  of  which  were  charged  to  "  Profit  and  Loss  "  account 
and  correspond  respectively  to  Items  11  and  12  of  the  Profit  and  Loss 
Statement,  page  8.    The  balance  of  "Inventory  8/31/14,"  $13,379.79, 


29 

was  then  brought  forward.  It  agrees  with  Item  13,  Net  Inventory  at 
End  of  Period,  Profit  and  Loss  Statement,  page  8,  and  also  with  Item  6, 
Inventory  at  Beginning  of  the  third  period,  Profit  and  Loss  Statement, 
l)age  12.  This  balance  on  the  books  is  to  be  closed  into  "  Merchandise  " 
account  for  the  third  period,  and  in  this  way  the  necessary  information 
for  the  combined  basis  method  is  easily  available. 

After  the  books  have  been  closed  for  the  second  period  the  trial 
balance  is  as  follows :  — 

Trial  Balance,  Second  Period,  August  31,  lilll 

Cash $437.23         Notes  Pay $12,.500.00 

Inv.  8/31/14 13.379.79         Surplus 1,317.02 

$13,817.02  $13,817.02 

A  table  similar  to  that  for  the  first  period,  page  25,  would  make  it 
readily  apparent  from  which  book  account  each  item  of  the  Profit  and 
Loss  Statement  of  the  Harvard  System  of  Accounts  for  Shoe  Retailers, 
page  8,  was  taken  —  Item  13,  Net  Inventory  at  End  of  the  first  period, 
being  identical  with  Item  6,  Inventory  at  the  Beginning  of  the  second 
period. 

To  continue  with  these  accounts  through  the  third  and  last  period, 
the  balances  at  the  beginning  of  the  third  period  according  to  the  fore- 
going trial  balances  are:  — 

Inventory  8/31/14  Cash 

Balance..    $13,379.79  Balance..   $437.23 

Notes  Payable  Surplus 

Balance..    $12,500.00  Balance..    $1,317.02 

At  the  end  of  the  third  period,  after  closing  "  Inventory  8/31/14  " 
balance  into  "  Merchandise  "  account  for  the  third  period,  but  before 
the  other  accounts  have  been  closed,  the  books  look  as  follows:  — 


45B773 


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32 


The  trial  balance  of  these  accounts  for  the  third  period  is  as  follows:  — 

Trial  Balance,  Third  Period,  Februarj'  28,  1915 

Cash $190.57         Notes  Pay $8,500.00 

Inv.  2/28/15 11.804.25         Surplus 3,494.82 

$11,994.82  $11,994.82 

The  same  methods  would  be  followed  for  the  fourth  and  each  succeed- 
ing period.  Although  the  books  do  not  show  a  separate  account  for 
each  item  of  the  Profit  and  Loss  Statement,  the  table  on  page  25  shows 
how  the  Profit  and  Loss  Statement  is  derived  from  the  accounts  kept  as 
outlined  above.  From  these  accounts  it  is  possible  to  keep  a  memo- 
randum of  the  actual  cost  of  depreciation  at  each  inventory  such  as 
the  following:  — 


Period 

Inventory  less 
discount 

Depreciation  reported. 

Cumulative  depreciation 

cost  (See  Inventory 

accounts) 

Actual 
depreciation 
cost  for  each 

period 

1st  2/28/14 
2d    8/31/15 
3d    2/28/15 

$14,751.60 
14,866.43 
13,115.83 

10% 
10% 
10% 

$1,475.16 
1,486.64 
1,311.58 

$1,475.16 

11.48 

-  175.06 

This  table  shows  the  actual  cumulative  depreciation  at  any  period 
and  the  actual  depreciation  cost  for  any  period.  For  example,  not 
only  is  there  no  depreciation  cost  for  the  third  period  but  it  is  even 
reduced  $175.06,  and  the  cumulative  depreciation  at  the  end  of  the 
third  period  is  reduced  by  the  same  amount,  because  the  inventory 
for  this  period  is  less,  as  was  explained  in  Part  I.  This  table  also 
makes  clearer  the  relation  as  presented  (page  14)  between  the  gross 
basis  method  and  the  combined  basis  method  of  the  Harvard  System 
of  Accounts  for  Shoe  Retailers. 


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